Share Buyback Announcements Plunge, Stocks Risk Getting Clocked

| About: SPDR S&P (SPY)

Who's going to replace that "relentless bid?"

In 2015, S&P 500 companies bought back $569 billion of their own shares, down just a smidgen from $572 billion in 2014, according to FactSet. That's a combined $1.14 trillion in stock repurchases. With the S&P 500 market capitalization at $18.8 trillion currently, corporate buybacks over the past two years have mopped up about 6% of the total float in dollar terms. And this has been happening year after year with increasing vehemence since 2010.

While some sectors already cut back in 2015, buybacks soared 44% in the Industrial sector and 26% in the Consumer Discretionary sector. Companies buying back their own shares act purposefully as the relentless bid, with the sole goal of driving up share prices. They want to buy high! And it works.

These shares don't sit in an account waiting to be dumped on the market. Companies cannot sell the shares that they previously repurchased. Selling shares is considered "raising capital," which requires companies to jump through all kinds of regulatory hoops, often followed by a sell-off. Corporate share repurchases won't ever reverse and turn into selling pressure. These shares just just evaporate.

So, share repurchases add enormous buying pressure. IBM Corp. (NYSE:IBM), which most recently reported its 16th year-over-year revenue decline in a row, ending up with its worst quarterly revenues in 14 years, is a master at this. That's why its stock price magically keeps creeping back up after the post-earnings announcement beat-down.

Share buybacks have been a key part of the well-oiled Wall Street machinery of financial engineering. They hide the dilutive effects of stock compensation programs and stock-based mergers and acquisitions. And they inflate earnings per share by lowering the number of shares outstanding. In return, they strip the company of equity capital. So, IBM's "tangible" net equity (equity minus "goodwill" and "intangible assets") have reached negative $23.8 billion, and its liabilities have ballooned to $103.9 billion - its balance sheet has turned into a financial sinkhole.

Hounding reluctant companies into buying back their own shares is also one of the favorite tools by which "activist investors" - corporate raiders, as they used to be called - hope to make a quick buck. Carl Icahn and Apple (NASDAQ:AAPL) are a prime example. But the tactic is developing a nasty habit of backfiring: Apple is down 28% from a year ago, and Icahn has bailed out.

Buyback announcements - not actual share buybacks - totaled $2 trillion since 2013. Many of those announced buyback programs stretch over several years, and some of those announced buybacks haven't been executed yet. But buyback announcements are suddenly plunging. Christine Hughes, Chief Investment Strategist at OtterWood Capital:

According to JP Morgan Quant Marko Kolanovic, announced buybacks have dropped 40% ($250 billion) on a 12-month trailing basis. Share buybacks take approximately 6 quarters to execute so the recent drop will translate into roughly $40 billion less equity demand per quarter.

This chart (via OtterWood Capital) shows the relationship between buyback announcements and the S&P 500 since before the Financial Crisis.

Note how the crazy boom in the S&P 500 (green line) that kicked off in 2009 stalled out in December 2014 and began vacillating wildly - after buyback announcements had stalled over a year earlier, in terms of dollars (red line) and in terms of the number of companies announcing buybacks (blue line). Both of them have begun plunging:

But that plunge in buyback announcements hasn't made its way to reality yet, and the waves of prior buyback announcements are still being implemented and are still propping up the S&P 500 at this point. But gradually, that plunge in announced buybacks is going to translate into plunging actual buybacks.

That divergence between buyback announcements and the S&P 500, which is off only 3%, is adding some spine-chilling risks to stock prices as the relentless bid that bought over $1 trillion in stocks over the past two years recedes. And given the crazy valuations, volunteers, such as retail investors, are reluctant to come out of the woodwork to replace that relentless bid.

US stock indices - S&P 500 -3.0%, Dow -3.7%, and Nasdaq -8.3% - are the cleanest dirty shirts globally, in an unsavory crowd where every major stock index is bleeding red ink. But the small-cap Russell 2000 is already down 11.6%. And the USA IPO index, down 23.7%, has joined the growing group of indices that have gotten caught up in the NIRP rout. Read... "What the Heck's Going on in Global Stocks?"